Italy and Spain too big to be saved

Fears have been raised for unemployment-ridden Spain and indebted Italy, two countries are too big to be saved by Europe's bailout fund.

14.03.2012

Eurozone finance ministers opened the door to using the currency union's bailout fund to buy up distressed Greek bonds, thereby cutting the country's overall debt load as they scrambled to stop the region's debt crisis from spreading to larger economies like Italy and Spain.

The ministers' statement Monday — which came after hours of discussions and was scant on details — followed one of the worst days in the markets for Italy and Spain, the third and fourth largest economies in the eurozone.

The fear is that while Europe's €750 billion bailout fund can support already bailed out Greece, Portugal and Ireland — only 6 percent of the eurozone economy — unemployment-ridden Spain and highly indebted Italy are too big to save.

The 17 eurozone finance ministers said they "stand ready" to contain the risk of contagion, "including enhancing the flexibility and the scope" of the European Financial Stability Facility, the eurozone's portion of the overall bailout fund, also known as the EFSF. They also said that they will consider giving already bailed out countries more time to repay their loans and cutting the interest rates they have to pay.

While ministers did not explain what this wider "flexibility and scope" will mean in practice, the statement comes after the eurozone's biggest banks and investment funds called for EFSF-funded buybacks as part of a plan to get the private sector to contribute to a second bailout for Greece.

Greek bonds are currently trading far below face value. If the EFSF bought up these bonds at current prices, or swapped them for EFSF-issued bonds of the same value, that could cut down Greece's overall debt, which is set to top 160 percent of economic output.

Eurozone banks and investment funds have been locked into negotiations on how they can contribute to a new rescue package for Greece — on top of the €110 billion the country was granted last May. The EU says Greece will need an extra €115 billion to keep it afloat until mid-2014, although some of that money is expected to come from selling state assets.

However, the talks with banks have proven difficult, because the eurozone has said that any private sector involvement would have to be voluntary and because rating agencies have warned that even market-friendly proposals will likely be seen as a partial default by Greece. A default rating could spread panic on financial markets and hurt Greek banks, the biggest holders of Greek bonds.

The buybacks have emerged as a potential bargaining chip the negotiations, because they would lower the weight of Greece's debts and relieve banks and other private investors of risky assets on their balance sheets. Faced with the prospect of a messy default by Greece in the near future, which could leave them with very little money, a buyback below face value may be seen as a better option. They could also prove a boon for hedge funds, which may have bought the bonds at even lower prices.

In an article in German daily FAZ, Martin Blessing, the CEO of Germany's Commerzbank, proposed allowing bondholders to exchange existing bonds for new ones at a 30 percent discount, 30-year maturity and low 3.5 percent interest rate. Commerzbank is a major holder of Greek government bonds.

While the eurozone ministers opened the door for buybacks — which they had firmly excluded as recently as March — they appeared to move away from a previous promise to avoid a default rating for Greece at all cost. Monday's statement only said that the European Central Bank "confirmed its position ... that a credit event or selective default should be avoided."

That's much weaker language than in previous statements, where the ECB's position had been backed by the finance ministers. It signals that finance ministers are considering harsher options for private sector involvement than the previously favored bond roll-overs.

The ministers' statement was big on promises, but low on details, which Jean-Claude Juncker, the prime minister of Luxembourg who chairs the finance ministers meetings, promised would be filled in "shortly, and shortly means as soon as possible."

As so often over the past year and a half, the eurozone finds itself at a new peak in its debt crisis, with leaders in the most threatened countries urging quick action to clarify the plans for a second Greek package, which ministers have been putting off.

"The transition from crisis to crisis, at such a weak stage of recovery, given the cacophony in the press and the insecurity of the public, is a choice that Greece can no longer bear," Greek Prime Minister George Papandreou said in a letter to Juncker Monday. "Concerning Greece, it is necessary this time to reach an effective solution that will guarantee the attaining of three basic targets: Debt viability, market access and the providing of means to restart the growth of the Greek economy."

Spanish Prime Minister Jose Luis Rodriguez Zapatero meanwhile called for a "swift and precise clarification" of how a second bailout for Greece might work, to help ease the tension that has engulfed his country as well as Italy in recent days.

Separately, Christine Lagarde, the new leader of the International Monetary Fund, said Monday in Washington that Italy's economic growth "has to improve" to help bring its deficit down to about 3 percent of its economy in 2012.

The IMF, which contributed about a third of the cost of last year's bailout fund, is being represented in Brussels by John Lipsky, the IMF's top deputy.

Lagarde, in an interview with a group of reporters, said Greece has reduced its debt by an amount equivalent to 5 percent of its economy, "a significant achievement."

But "we all know this is not sufficient, more needs to be done," she added.

Investors on Monday sold off European stocks while the yields, or interest rates, on the bonds of Spain and Italy reached euro-era highs. The yield on Italian 10-year bonds jumped to 5.7 percent from 5.3 percent at the beginning of trading, following sharp rises on Thursday and Friday. Yields on Spanish 10-year bonds rose to 6 percent from 5.7 percent.

Italy's FTSE MIB stock index closed off 4 percent, and the euro sagged by more than a percent to $1.4044, for a time dipping below $1.40.

Italy came under market pressure after remarks last week by Premier Silvio Berlusconi criticizing his Finance Minister Giulio Tremonti. Berlusconi's sniping has cast doubt on the government's political will to carry through with Tremonti's proposals to find €48 billion in new savings over three years and eliminate the country's budget deficit by 2014.